Reducing Tax for an NHS Consultant Undertaking Private Work

An interesting tax question is posed in The Telegraph today, by a reader referred to as Peter; His partner, an NHS consultant earning above the £50,270 per year National Insurance upper limit and also taxed at the 40pc rate, is thinking of starting work at a private clinic. Peter is aware that setting up as a limited company, where private earnings are paid to the company instead of as personal income, is common amongst her peers.

This approach sparks a pressing question: Would this be a beneficial & efficient move for them to make?

Sole Trader or Limited Company?

Peter’s partner could operate as a sole trader and pay 40pc income tax up to the additional-rate threshold of £125,140 — with the percentage rising to 45pc beyond. On top of that, she would also owe ‘Class 4’ National Insurance at 2pc, for an effective tax rate of 42pc.

However, she also has the option to operate as a limited company. In this case, she would invoice her services, and corporation tax would apply to the profits. This option can yield potential tax savings in specific circumstances, although it does come with added costs and a more complex tax situation.

Calculating The Tax

It’s worth noting that the standard corporation tax rate is 25pc, but typically, a reduced rate of 19pc applies for the first £50,000 of profits. If the fees from private patients amount to £10,000, £1,900 is claimed as corporation tax, leaving £8,100 to pay as a dividend, which would be subject to a 33.75pc income tax. The effective combined tax rate would then amount to approximately 46.34pc.

This formidable tax rate stems from an increase in the tax rate on dividends by 7.5 percentage points introduced by the Chancellor in recognition of the growing appeal of service companies as a tax-saving measure, following reductions in corporation tax rates. Complicating matters, the dividend allowance, initially at £5,000, has been cut down multiple times—sitting at £1,000 in 2023-24 and slated for a further decrease to just £500 from 2024-25 onwards.

So, why employ a service company despite these issues?

Benefits of Using A Service Company

There are two compelling reasons that consultants may opt to use a service company, especially when considering tax obligations.

The first advantage lies in its flexibility; owners can control how much they take as annual dividends. One could sidestep withdrawing dividends when their income lies between £100,000 and £125,140 to avoid heightened tax rates—60pc on earnings and profits, and 53.75pc on dividends. Essentially, they can store funds within the company for the time being.

The second potential perk involves the ability to establish the company with another shareholder who could be taxed at a lower rate. If shares are held equally with a basic-rate taxpayer spouse, with a dividend tax rate currently at 8.75pc, the total effective tax rate would only be about 26pc. This modification would result in an overall combined rate of 36pc.

Potential Complications

This arrangement is commonly used and generally effective; however, it’s crucial to exercise caution.

The case of Mr and Mrs Jones, owners of Arctic Systems Ltd who had one ordinary share each in their company, examined the application of this tax model. HMRC contested that, due to Mr Jones being the primary worker and his wife not working in the business, he should pay tax on her dividends. The House of Lords unanimously ruled against HMRC, finding that tax arrangements should not discriminate against married couples. This decision is not absolute and doesn’t necessarily apply to unmarried couples, creating potential room for HMRC to challenge similar setups.

The Bottom Line

In summary, using a service company could indeed lead to tax savings, but the decisions should be determined by your specific circumstances. You should consider the extra costs and the trade-off between these costs and the potential tax benefits. Navigating this territory can be difficult, but through careful consideration of all the variables, you could find a satisfying solution to tax issues for supplementary private work.